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Lack of planning, capitalization behind many restaurant failures

Unfortunately, many small businesses fail every year. Restaurants are prevalent among that group. What are some causes of those failures and how can they be avoided?

CPA Chris Parker, who’s been involved with the Mississippi Hospitality and Restaurant Association since the mid-1990s, says lack of planning and capitalization are the leading causes of restaurant failure.

“Most people go into a restaurant with next to nothing left in the bank by the day they open, counting on sales to cover everything from the opening day forward,” he said. “They need three- to six-months operating capital in the bank to make it through the startup. Costs are usually higher in the beginning because they are unsure how much food to keep on hand and how much labor to schedule. That, consequently, drives up food and labor costs, which decreases profit.”

Mike Cashion, executive director of the association, agrees and adds that no one should go into the business without a comprehensive feasibility study and good business plan.

“Those are things we see a lot,” he said. “If they do a feasibility study right, they will know if the location, concept and everything will work, and that turns into a financial issue. A thorough feasibility study before opening a restaurant can reveal a product the market is not ready for or won’t support. So much goes into opening a restaurant. People don’t always realize that and sometimes shortcut it and do not have enough reserve funding and cash flow.”

Inexperienced people think that restaurant ownership is all “glad-handing” with their friends, Parker says. “They lease space, put together a menu, arbitrarily decide what to charge and open the doors because a few of their friends liked some dishes they cook at home, and they are tired of having a boss tell them what to do at their current job,” he said.

He observes that non-national chain restaurants making a profit have owners working 12- to 14-hour days, even working the kitchen when a line cook does not show up.

Noting that many restaurants operate on a 2% to 4% profit margin, business counselor Teresa Speir says lenders tell her that restaurants have a higher-than-average failure rate.

“Restaurant owners must watch all the pennies,” she said. “Restaurants have a problem with inventory, too. It can walk out the door or be mismanaged by staff, leading to higher costs.”

A counselor with the Gulf Coast Small Business Development Center, Speir also points out that restaurant owners have to keep long hours and deal with staffing problems, things that over time wear them down physically and mentally.

She also adds her voice to the tendency for new restaurant owners to undercapitalize. “The barrier to entry can be low by purchasing used equipment, and owners typically underestimate their operating costs,” she said. “Therefore they are undercapitalized, and this makes it easier for them to just close the door and walk away.”

Cashion, whose organization represents approximately 2,200 locations, notes that new restaurant owners quickly find out how unglamorous the industry is.

“Sometimes someone is a great cook. They like to cook for their friends and think owning a restaurant will be easy,” he said, “and that they will open the door and start making money.”

Restaurants, however, are more than just the food and having enough capital. “No business in any industry will maintain a long-term edge based solely on a product,” Cashion said. “That’s not what will break or make it. It’s the whole experience.”

Speir says restaurateurs have to be as concerned about the front of the house as well as what comes out of the kitchen. “Make sure you have excellent customer service. A great staff can overcome average food,” she advises. “Be consistent in food and service. A trained staff is a must.”

Restaurants face challenges with the marketing/sales dynamic, says Tim Mask, vice president, brand planning and development with Maris, West and Baker advertising agency.

“All marketing efforts should focus on driving and sustaining necessary traffic,” he said. “Probably the primary reasons restaurants fail, from the marketing perspective, is a lack of investment in a sustained marketing effort. Many restaurants spend a lot during grand opening periods but drastically cut or eliminate marketing shortly thereafter. One of the primary rules of marketing is that you can’t rely on reputation alone.”

Even with exceptional food and stellar service, restaurants can’t expect an initial three-month ad blitz to sustain a large customer base, he believes.

“It is true that if you’re not putting your brand ‘out there,’ you fall quickly from the consumer’s radar screen,” he said. “With the restaurant business operating under an extremely tight profit margin model, many restaurateurs view marketing as an unnecessary expense. That model underscores the importance of maintaining a robust marketing effort.”

When a business depends on volume, Mask advises, making an investment in getting the word out to as many potential customers as possible is the best tactic.

Parker advises would-be restaurant owners to consult with their accountant and the restaurant association for advice prior to making the decision about opening a restaurant.

“Money spent planning up front will help a restaurant succeed more than spending money to try and turn around a failing restaurant,” he said. “Plan out every detail you can think of ahead of time before deciding to open the restaurant.”

He also advises that the menu, right down to the garnishes, should be planned with cost detail that includes a waste factor. Fast food restaurants should calculate paper costs. All types of restaurants should figure out fuel charges, labor costs needed for each shift, rental space, insurance and common area maintenance. Demographic information on the area of location is useful, too.

“Start small. You don’t need the newest location with the highest rent or a million dollar building,” Parker said. “Keep overhead as low as possible and service, food quality and hands-on management as high as possible.”

The Mississippi Hospitality and Restaurant Association offers a variety of training classes to help restaurant owners. Cashion suggests that anyone interested contact the association to learn more. On the Coast, Speir is coordinating an eight-week course for new and potential restaurant owners. It is a collaboration of the Small Business Development Center and several other organizations, including the restaurant association.

Contact MBJ contributing writer Lynn Lofton at llofton656@aol.com.


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